Pty Ltd Company

Compliance with Company Law

Pty Ltd companies must adhere to the provisions of the Corporations Act 2001, which is the primary legislation governing corporations in Australia. This includes following regulations related to company structure, governance, and operations.
It is essential to maintain accurate company records, including shareholder registers, financial statements, and minutes of meetings. These records should reflect the company’s financial status, ownership structure, and decision making processes.
Pty Ltd companies are also required to conduct annual general meetings (AGMs) to engage with shareholders, discuss financial matters, and ensure transparency in corporate affairs.

 

Reporting obligations

To maintain transparency and accountability, Pty Ltd companies must submit annual financial reports to the ASIC. These reports comprise financial statements that provide a snapshot of the company’s financial health, directors’ reports outlining the company’s performance and prospects, and auditor’s reports confirming the accuracy of the financial statements.
Any significant changes within the company, such as alterations to its registered office address, directors, or shareholders, must be promptly reported to ASIC to keep its records up to date.

Tax obligations

Pty Ltd companies must fulfill their tax obligations, which include registering for an ABN and GST if applicable.
These companies must keep proper accounting records to accurately track income, expenses, and other financial transactions. This information is essential for preparing and submitting tax returns to the tax officials.
Compliance with tax regulations is critical, as failure to meet tax obligations can result in penalties and legal consequences.

Shareholder responsibilities

Pty Ltd companies are required to maintain a register of shareholders, which includes detailed information about each shareholder, such as their names, addresses, and shareholdings. This register serves as an official record of ownership and is crucial for communication and decision making.
Shareholders must be provided with share certificates as evidence of their ownership in the company. These certificates specify the number and class of shares held by each shareholder.
Regular updates on the company’s activities, financial performance, and strategic plans should be communicated to shareholders to ensure transparency and informed decision making.

Registration renewal

Pty Ltd companies must annually renew their registrations with ASIC to maintain their legal status. This renewal process involves paying the necessary fees and updating any relevant company information. Failing to renew registration in a timely manner can result in the company losing its legal status and facing potential penalties. Therefore, it is essential to keep track of renewal deadlines and comply with ASIC’s requirements.

 

What is a Company Constitution?

A Company Constitution is essentially a document that establishes the regulations for how a company is run, detailing the roles and relationships between the directors and shareholders. It serves as a foundational guide for managing the company’s operations and resolving any conflicts that arise.  

A constitution is necessary for companies because it provides specific guidelines on how the company should be governed. In Australia, the ASIC mandates that every company must decide whether to draft its own constitution, follow the replaceable rules set forth in the Corporations Act 2001, or use a mix of both approaches. This decision needs to be made before a company is officially registered. 

Furthermore, ASIC requires certain types of companies, specifically special purpose companies and no liability public companies, to have a constitution. This is because these kinds of companies have particular needs and responsibilities that require specific governance structures beyond what the replaceable rules provide. Therefore, having a constitution is compulsory for these companies to ensure proper regulation and management. 

What Should a Company Constitution include? 

A Company Constitution is a comprehensive document that outlines the guidelines for managing a company’s operations and structure. It should address several key areas to ensure clarity and organisation within the company: 

• Company Structure: This includes the basic setup and framework of the company. 

• Share Related Matters: Details about issuing, transferring, and classes of shares should be included, along with information about share certificates. 

• Governance and Meetings: The constitution should define how meetings are governed and organised, including voting procedures and the roles and responsibilities of the company secretary if one is appointed. 

• Directors and Management: The document must cover the appointment and removal of directors, their powers, and how they are managed. 

• Financial Aspects: Guidelines on handling dividends and other financial procedures should be specified. 

• Execution of Documents: There should be clear rules on how company documents are executed. 

• Shareholder Rights: Rights and obligations of shareholders, beyond the basics of shareholding, should be clearly laid out. 

• Amending the Constitution: The process for making amendments to the constitution itself should be defined to accommodate future changes in company operations or regulations. 

Thus, the constitution serves as a formal guide to ensure that all aspects of company governance are handled consistently and legally. 

When Should a Company Adopt a Constitution? 

A company has the flexibility to adopt a constitution at two possible stages: either before it is registered or after. 

If a company chooses to establish a constitution prior to its registration, all members are required to give their written consent to the terms outlined in the constitution. This ensures that all founding members agree on the governance and operational rules from the outset. 

On the other hand, if a company decides to adopt a constitution after it has been registered, it must secure the approval of its shareholders through a special resolution. This means that at least 75% of the shareholders who have voting rights must agree to the adoption of the constitution. This process allows for shareholder input and consensus on how the company should be governed going forward. 

If a company doesn’t adopt its own constitution, it automatically falls under the default rules outlined in the Corporations Act 2001, which are referred to as replaceable rules. These rules provide a standard structure that governs the company unless a specific constitution is put in place. 

How to Adopt a Company Constitution 

To establish a constitution when a company is being formed, every initial member must consent to it in writing. If a company wishes to introduce a constitution after it has been incorporated, it must follow a specific procedure. 

Initially, the company needs to distribute a notification regarding a special resolution and a general meeting. Publicly listed companies are required to provide at least 28 days’ notice before the meeting, while other types of companies must issue a notice at least 21 days in advance. The notice should specify the time, date, and location of the meeting, detail the primary topics of discussion, and express the intention to adopt the resolution. 

The next step involves holding a general meeting where a special resolution for adopting the constitution is presented. To pass this resolution, at least 75% of the voting members must support it. The process may also involve additional requirements laid out in the company’s original constitution concerning the passage of resolutions. 

 

What are the Replaceable Rules?

Replaceable rules are a set of default provisions found in the Corporations Act that are applicable to companies. These rules can be adapted or entirely replaced by a company’s constitution, except for certain mandatory rules that must be adhered to by all companies. 

Here are the key aspects of replaceable rules: 

Applicability: They do not apply to companies with a single shareholder or director, as these entities are governed by a separate set of rules in the Corporations Act. 

Coverage: The rules includes several areas including: 

• Appointment and removal of directors. 

• Rights of shareholders to access company books. 

• Remuneration of directors. 

• Powers vested in directors. 

• Conduct of meetings for directors and members. 

• Handling of shares in events such as a shareholder’s death or bankruptcy. 

• Rights associated with shares. 

Legal Consequences: A violation of replaceable rules is not considered a violation of the Corporations Act itself. Since these rules establish contractual obligations between the company and its shareholders, any breach is treated as a breach of contract, rather than a breach of statutory duty. This distinction highlights the contractual nature of the rules within the framework of company operations and shareholder relations. 

Why Choose a Constitution Over Replaceable Rules

Here are several compelling reasons why a constitution often proves more beneficial for aligning with specific corporate needs than the replaceable rules: 

Tailored Corporate Governance 

A company constitution offers the advantage of being a bespoke document tailored to the specific needs of a company. Unlike replaceable rules, which are general and may not cover all scenarios, a constitution can be meticulously crafted to align with the unique operational and strategic requirements of a business. This makes it simpler and more efficient for companies, particularly larger ones, to manage their governance without constantly referring back to the broader Corporations Act. 

Enhanced Control Over Leadership Dynamics 

Replaceable rules typically afford significant powers to shareholders, such as the ability to remove directors. This can introduce instability within the company’s leadership, particularly if shareholder interests are diverse or conflicting. A constitution can restrict or modify these powers, providing a more stable governance structure that supports long term strategic leadership. 

Flexibility in Financial Management 

Constitutions allow companies to issue partly paid shares and manage the demands on these shares, known as calls. This flexibility is crucial for managing cash flow and financing needs, enabling a company to effectively control when and how much shareholders are required to contribute towards their shareholdings. 

Diverse Equity Structures 

A constitution enables the creation of multiple classes of shares, each with specified rights concerning voting, dividends, and other privileges. This is particularly useful for companies seeking to attract different types of investors or to reward certain stakeholders with enhanced rights without altering the overall balance of control. 

Control Over Share Transfers 

Including pre emptive rights in a constitution allows a company to manage the issuance and transfer of shares more closely. This can be critical for maintaining continuity in ownership and control, preventing unwanted external influences, and preserving shareholder value. 

Simplicity in Modifications 

One of the most significant advantages of a company constitution is its adaptability. While replaceable rules are static and can only be amended through legislative reform, a constitution can be modified as needed. This allows companies to quickly adapt to changes in the business environment, regulatory landscape, or internal company needs. 

How to Amend a Company’s Constitution 

Amending a company constitution involves a structured process centered around passing a special resolution. Initially, a review of the current constitution is necessary to understand the specific stipulations for amendments, including identifying any clauses that cannot be altered. 

Notice of the special resolution must be provided to all relevant parties. For private companies, at least 21 days’ notice is required, while public companies must give 28 days’ notice. This notice should detail the location, date, and time of the meeting where the resolution will be discussed, along with information on the proposed changes, an agenda, and instructions for proxy voting and electronic voting. 

For the amendment to be officially adopted, the special resolution must receive approval from at least 75% of the votes cast in its favour. Following the resolution’s passage, private companies must provide an updated constitution to any member who requests it within seven days.  

What is a Company Director?

The definition of Director according to the Corporations Act is described through the following criteria:

• Individuals who have received legitimate appointment as a director.
• Those acting in a capacity synonymous with that of a director, notwithstanding the absence of a formal appointment.
• People whose instructions are consistently adhered to by other members within the company.

 

Who is Eligible to be a Company Director?

The role of a company director within Australian companies is primarily defined under Section 9 of the Corporations Act 2001. This definition outlines that anyone appointed to the director’s position qualifies as such. Generally, there are minimal restrictions on who can hold this position.

Nonetheless, individuals may be prohibited from becoming directors by either a court or the Australian Securities & Investments Commission (ASIC). This prohibition typically occurs due to past legal infractions or violations of the Corporations Act itself. The law specifies that any adult in Australia can become a director, subject to fulfilling certain legal criteria:

• Directors must be at least 18 years of age.
• They are required to provide written consent to assume the role and its associated responsibilities.
• In situations where a company has only one director, that individual must live in Australia.
• Companies with multiple directors must have at least one director who is an Australian resident.

Additionally, Section 206B of the Corporations Act outlines specific disqualification criteria that can render an individual ineligible for the director role.

For private companies, as per Section 201A of the Corporations Act, there is a requirement for at least one director, who must also be an Australian resident.

The regulation distinguishes between Australian residents and non residents based on their visa status or citizenship, noting that foreign residents typically do not hold permanent visas or Australian citizenship.

Moreover, responsibilities typically associated with directors can also be applied to individuals not officially recognised as directors but who either act in a director like capacity or whose directions are followed by officially appointed directors concerning their duties.

A permanent resident is eligible to be appointed as a director of an Australian company.

 

Company Director Duties

Company directors are tasked with several critical responsibilities to ensure the ethical and legal operation of the business. These duties, rooted in the need for prudent management and governance, are crucial for the company’s sustainability and legal compliance.

Exercise Care and Diligence

Directors must approach decision making with a level of care and attention that reasonably cautious individuals would exercise under similar circumstances. This involves a thorough evaluation of financial activities, such as reviewing financial statements and transaction reports, to safeguard the company against unnecessary financial risks.

Act with Honesty and Integrity

The role of a director requires actions and decisions that are honest and aligned with the company’s best interests. This includes avoiding actions that could enrich the director at the company’s expense, thus ensuring decisions benefit the company as a whole rather than individual interests.

Avoid Insolvency

A fundamental duty is to monitor the company’s financial health closely, particularly its ability to pay debts as and when they’re due. This vigilance helps in preventing the company from engaging in business while insolvent, a state where the company is unable to meet its debt obligations on time.

Use Information Properly

Directors have privileged access to vital company information, such as contracts, financial data, and records of transactions. Misusing this information for personal gain or to the detriment of the company and its stakeholders is strictly prohibited.

Maintain Accurate Records

It falls within a director’s remit to ensure the company keeps accurate and comprehensive records of its financial transactions and position. These records are essential for transparency, accountability, and compliance with regulatory requirements.

Disclose Personal Interests

Directors must be forthcoming about any personal interests that might influence their decisions or actions regarding the company. This transparency is crucial to avoid conflicts of interest and to ensure that decisions are made in the company’s best interests. When in doubt about the relevance of a personal interest, erring on the side of disclosure is advised to maintain integrity and trust.

 

Director Liability

Insolvent Trading

Directors may face liability for the company’s debts, losses, or financial obligations in specific situations, particularly when the company is unable to settle its debts as they become due, indicating insolvency. A core responsibility of directors is to prevent the company from operating if it is insolvent.

Several signs can suggest a company is facing insolvency, including:

• Consistently low profits or inadequate cash flow from business operations.
• Difficulties in timely payment to suppliers and creditors.
• Suppliers’ refusal to provide further credit to the business.
• Challenges in adhering to loan repayment schedules or maintaining overdraft limits.
• Legal actions initiated or threatened by creditors or suppliers for unsettled debts.

To ascertain whether a company is trading while insolvent, directors need to evaluate:

• Cash Flow: The capability of the company to meet its current and future debt obligations as they become due based on projected cash flows.
• Overall Financial Position: The feasibility of liquidating assets in a timely manner to pay off debts as they are due.

Allowing a company to continue its operations while insolvent, poses a significant risk of violating the Corporations Act, which enforces both civil and criminal penalties for directors who fail to adhere to their duties of preventing insolvent trading.

Personal Liability of Directors for Company Losses

Directors can incur personal liability if their failure to fulfil their duties leads to losses for the company. Such situations may involve illegal actions or violations of both civil and criminal statutes within the Corporations Act, potentially requiring the director to compensate the company for the incurred losses. Importantly, the responsibility of a director can persist beyond the cessation of the company’s operations or its deregistration.

Tax Related Director Liabilities

See our Director Penalty Notice article for details of these tax related director liabilities: PAYGW, Superannuation Guarantee Charge (SGC), GST, Wine Equalisation Tax (WET), and luxury car tax.

What is a Company Secretary?

A company secretary is a company officer whose role is to ensure the company adheres to legal and regulatory requirements.

In larger companies, the company secretary has a significant impact on the functioning of the company’s board. The company secretary advises the board on ethical standards and corporate conduct, and provides insights into the implications of the board’s business decisions.

Eligibility Criteria for a Company Secretary  

According to the Corporations Act 2001, all companies apart from proprietary limited (Pty Ltd) companies must appoint at least one company secretary. Below are the criteria that must be met by anyone assuming the role of a company secretary in such companies:

• Age and Status Requirements: The individual must be a natural person who is over the age of 18. This ensures that the appointee is legally an adult and can be held accountable for their responsibilities.
• Skills and Experience: While there are no specific educational or professional qualifications mandated by law, the person designated as company secretary should have the relevant skills, knowledge, and experience required to manage the legal and compliance aspects of the company effectively.
• Financial Integrity: The candidate must not be an undischarged bankrupt. This requirement helps ensure that the company secretary is financially responsible and capable of managing or overseeing the financial practises of the company without any legal encumbrances.
• Employment Status: The role of the company secretary can be filled either by an employee of the company or through a contracted service provider. This flexibility allows companies to choose an arrangement that best suits their operational structure and needs.

Companies Unable to Appoint a Company Secretary 

In situations where a Pty Ltd company is unable to find a suitable individual to fill the role of company secretary, there is an option to hire third party service providers. These organisations specialise in company secretarial services and employ professionals who are well versed in the legal and regulatory requirements of corporate governance in Australia. Engaging a third party service provider allows smaller companies to fulfil their legal obligations without bearing the full cost of employing a full time company secretary.

 

Roles and Duties of a Company Secretary

Governing and Monitoring Company Operations 

A company secretary plays a pivotal role in the governance and operational oversight of a company. This includes supporting the board of directors by ensuring that the company adheres to corporate laws and regulations. Part of their role involves maintaining essential corporate records and handling the administrative duties that facilitate smooth operations.

Compliance Responsibilities 

One of the primary responsibilities of a company secretary is to ensure the company remains compliant with Australian corporate law. This entails maintaining the company’s registered office address, managing the members register, and overseeing the company’s share structure and the issuance of shares.

They are also responsible for lodging financial reports with the Australian Securities and Investments Commission (ASIC) and reporting any significant changes to the company’s structure or management.

Legal Obligations as a Company Officer 

In addition to their specific secretarial tasks, company secretaries are also recognised as officers of the company under Australian corporate law. This designation subjects them to many of the same legal duties as the company’s directors. These duties include:

• Duty of Care and Diligence: They must perform their roles with a high standard of care and attention to detail to prevent negligence that could harm the company.
• Duty to Act in Good Faith: Company secretaries must act honestly and with loyalty to the company, ensuring that their actions serve the company’s best interests and are aligned with its objectives.
• Prohibition Against Misusing Position: They must not use their position or the information they gain from it to benefit personally or to favour others at the company’s expense.
• Prohibition Against Misusing Information: Similarly, they must not use the knowledge acquired through their role to cause detriment to the company or for personal gain.

These responsibilities ensure that company secretaries act as key guardians of the company’s compliance and ethical standards, contributing to its overall integrity and success.

Administrative and Record Keeping Functions 

A company secretary ensures that all discussions and decisions made during board meetings are meticulously documented in the minutes. They are also responsible for organising meetings, ensuring they are called and conducted according to regulatory and company guidelines.

Compliance and Monitoring 

The company secretary plays a critical role in monitoring the board’s adherence to policies and procedures. They are tasked with preparing and delivering reports to the board, maintaining the accuracy of financial reports, and ensuring that all compliance related documents and procedures are up to date and implemented correctly.

Governance and Advisory Services 

This role includes providing the board with guidance on governance issues, assisting in the induction of new directors, and supporting the ongoing professional development of existing directors. The company secretary often advises the board on ethical standards and practises, helping to shape the corporate culture and ethical framework of the company.

Strategic Advisory and Board Performance 

In larger companies, the company secretary’s role encompasses a broader spectrum of responsibilities, particularly in advising the board on strategic matters. This includes providing critical information for decision making, organising board performance evaluations, and playing a significant part in risk management and corporate responsibility initiatives.

Director Support and Policy Development 

The company secretary manages the induction process for new directors, organises insurance for directors and officers, and helps formulate new policies for the board. They provide comprehensive advice on the conduct of company business and guide the board on the implications of their decisions.

Variation by Company Size 

The scope of responsibilities for a company secretary can vary significantly based on the size and structure of the company. In larger companies with many shareholders and a complex board structure, the role is more demanding, involving a wider range of tasks and greater responsibility. Conversely, in smaller companies with fewer shareholders, the role may be less intensive, requiring less frequent engagement with complex governance issues.

 

How to Appoint a Company Secretary

In Australia, public companies are mandated to appoint at least one company secretary, and it is required that at least one of these secretaries be a resident of Australia, regularly living in the country.

While private companies are not obligated to have a company secretary, if they choose to appoint one, the same residency requirement applies. The appointment of a company secretary is made by the company’s directors who also set the terms and conditions of the role, including salary.

Upon appointment, the company must file a notification with the Australian Securities and Investments Commission (ASIC) within 28 days. Additionally, the appointee must provide signed consent to accept the role of company secretary. This consent must be retained by the company as part of its official records.

What is a Holding Company?

A holding company is a type of company established with the primary purpose of acquiring and owning shares in other subsidiary companies. Unlike operating companies that directly produce goods or provide services to customers, holding companies don’t engage in such activities themselves. Instead, they hold controlling interests in other companies, which are referred to as subsidiaries.

The main function of a holding company is to own the assets of its subsidiaries and oversee their operations. Holding companies can take various forms, such as private companies, public companies, or trusts, depending on the objectives of the owners and the desired structure of the organisation.

The role of a holding company spans across businesses of all sizes and industries. Many prominent publicly traded corporations are actually holding companies, a fact that some investors may overlook.

Holding company structures are particularly favoured by large enterprises with diverse business units. For instance, a sizable corporation producing various consumer goods might adopt a holding company model, owning several subsidiaries.

Each subsidiary operates independently, with the holding company maintaining a controlling interest. Intellectual properties, equipment, and real estate may also be organised into separate subsidiaries, leasing these assets to the operating companies.

Holding Company Structure

In a typical holding company structure, subsidiary companies, known as operating companies, are primarily involved in manufacturing, selling, or conducting business operations. Meanwhile, other subsidiaries are tasked with holding assets such as real estate, intellectual properties, vehicles, equipment, or any valuable assets utilised by the operating companies.

The holding company may own all of the subsidiary’s shares or just enough to exert control over it. Control is typically achieved by owning a majority of shares or membership interests, ensuring that decisions align with the holding company’s objectives. This controlling interest can vary, with ownership as low as 51% in cases with multiple owners.

Each subsidiary operates under its own management team responsible for day to day operations. The holding company’s management oversees the subsidiary’s operations, including the appointment and removal of corporate directors or LLC managers. Major policy decisions, such as mergers or dissolution, are made by the holding company’s management. However, they do not directly participate in the day to day decision making processes of the operating companies.

Holding Company Financing

A holding company’s financing typically involves various methods. Management of the holding company decides on investment avenues while considering available funds.

A pure holding company secures funds for investments through equity sales in itself or its subsidiaries, borrowing, or earning revenue from subsidiary payments like dividends, distributions, interest, rents, and fees for back office services. In contrast, a mixed holding company generates revenue from its own business operations.

 

Holding Company Advantages

Asset Protection

A holding company serves as a guardian for valuable assets, from real estate to intellectual property. By owning these assets, the holding company insulates them from any financial liabilities or claims that might be directed at its subsidiary operations, offering a protective barrier.

Tax Benefits

Through careful structuring, holding companies can potentially lower the collective tax burden for themselves and their subsidiaries. Although recent tax law adjustments have placed some limits on these benefits, strategic placement in low tax jurisdictions remains a consideration.

Unified Management

Holding companies typically hold the reins when it comes to managing subsidiary companies. This arrangement allows for a unified approach to governance and management, potentially leading to better financial terms and streamlined operational practises.

As the central holder of all group assets, a holding company can manage these assets more efficiently, reducing the administrative burden on subsidiary companies and fostering a more unified strategy for asset utilisation and investment.

By centralising the ownership and management of assets, holding companies enable their subsidiaries to explore new ventures or exit existing ones without risking the core assets of the group. This approach offers flexibility and agility in navigating market opportunities.

 

Holding Company Disadvantages

Financial Burden

Establishing and maintaining a holding company and its subsidiaries entail significant costs, including formation fees and ongoing compliance expenses. Each entity must adhere to specific legal requirements, such as filing annual reports and paying franchise taxes, adding to the overall financial burden. Compared to a single operating company, the additional compliance obligations can lead to higher costs.

Increased Complexity

Holding companies may not necessarily own all shares of their subsidiaries, leading to management challenges, especially when dealing with minority owners. Conflicts may arise when the interests of minority owners conflict with those of the holding company. Additionally, the management of a holding company may lack expertise in the operations of its subsidiaries, posing challenges in making informed decisions.

The use of holding companies introduces complexity, particularly when managing multiple subsidiaries. This complexity can be amplified in publicly traded corporations with numerous subsidiaries, requiring robust entity management systems to track vital information and deadlines effectively.

Even smaller enterprises must maintain separate records and assets for each subsidiary to mitigate the risk of legal complications, such as piercing the corporate veil, which exposes assets beyond the subsidiary to creditors.

Interposed Holding Company Tax Avoidance – Beware

The Australian Taxation Office (ATO) reviews arrangements where an individual taxpayer accesses the profits of a private company in tax free form through the use of an interposed holding company. This is relevant to all arrangements when, viewed objectively, there is an indication that the dominant purpose of the arrangements is for the individual to avoid tax.

These company profits tax free schemes generally have the following features but may also include variations where the shares in the first company are pre CGT shares or a holding company is interposed between a trustee shareholder and a company:

• A private company (company A) has retained profits on which it may have paid tax at the corporate rate. Shares in company A are held by an individual who may also be a director of company A.
• The individual disposes of their shares in company A to another private company (interposed company), receiving shares in the interposed company in return.
• The shares in the interposed company are issued at a paid-up amount being the same as, or similar to, the net assets of company A which includes the retained profits of the first company.
• The individual applies a CGT roll-over, to disregard for tax purposes any capital gain on the disposal of those shares in company A.
• Company A declares a franked dividend to the interposed company and discharges its liability to pay the dividend by way of cash, cheque or promissory note.
• The interposed company then provides a loan to the individual, sourced from the dividend received. The loan may be interest-free and repayable at call.
• Neither the interposed company nor company A has a sufficient distributable surplus for Income Tax Assessment Act 1936 (Cth) (ITAA 1936) Div 7A to treat the loan made to the individual as a deemed dividend (whether directly from the interposed company or indirectly from company A).
• In some cases, company A could be wound up after the dividend payment to the interposed entity with the loan remaining uncalled and outstanding.
• The individual will have then obtained an amount tax-free in the form of a loan as opposed to without the interposed entity.

As outlined in the above scenario, Company A could have provided its accumulated profits to the individual by simpler means, such as paying a dividend or providing an interest-free, unsecured loan (assessable as a deemed dividend under ITAA 1936 Div 7A), both of which attract tax consequences for the individual. Hence, when viewed objectively, the purpose of the interposed entity appears to have a dominant purpose of avoiding tax.

Besides the general anti-avoidance provisions in ITAA 1936 Pt IVA, the ATO reviews these and similar arrangements to look for intention to repay the loan to decide whether the amount may be assessable under Div 7A. In addition, if the arrangements are found to be a “dividend stripping” scheme or operation, various legislation could apply to include the amount of the loan in the individual’s assessable income, and cancel the franking credit on the dividend paid to the interposed company.

What is a Subsidiary Company?

A subsidiary is a company that functions independently but is owned predominantly by another entity, referred to as the parent company. The key feature of this relationship is the parent company’s majority ownership, often exceeding 50%, granting it significant influence over the subsidiary’s management and strategic direction, including decisions made at the board level.

Despite this control, subsidiaries maintain their own legal identity, which provides several advantages to the parent company, such as reducing financial risk, offering tax benefits, and enhancing operational efficiency.

Corporations, especially large ones, may operate a network of subsidiaries across various regions and sectors, enabling them to expand their market reach, diversify their business activities, and effectively manage risks.

Example: 

If Company A can affirmatively answer any of the following questions, then Company A will be considered a subsidiary of Company B:

• Does Company B have the authority to appoint or dismiss most of the directors of Company A?
• Does Company B possess the right to cast more than half of the votes that could be cast by Company A’s shareholders?
• Does Company B own over half of the shares in Company A?

Moreover, if Company B owns 100% of Company A’s shares, then Company A is a wholly owned subsidiary of Company B. If the primary function of Company B is merely to hold shares in its subsidiaries, it is commonly referred to as a holding company. However, if Company B also engages in business operations beyond holding shares, it is generally termed as a parent company.

Indirectly Held Subsidiaries

A business entity can be part of a complex corporate structure where it is considered an indirectly held subsidiary. This situation arises when the business is owned by another entity, which in turn is a subsidiary of a larger, ultimate holding company.

Such a hierarchy allows for multiple layers of subsidiaries under the overarching control of one primary corporation. If an entity holds a minority share, meaning less than half of another company’s shares, it is not termed a subsidiary. Instead, these relationships are classified as affiliates, associates, or related entities.

These terms indicate a significant but not controlling investment by one company in another, reflecting a partnership or collaborative relationship rather than one based on direct control.

 

Subsidiary Company Functions

A subsidiary company plays a critical role within the structure of a larger corporate entity, often serving as a strategic component of a parent or holding company’s overall business strategy. Unlike the parent company, which primarily holds assets and its stock, the subsidiary is deeply involved in operational activities.

Operational Independence and Activities

The primary function of a subsidiary is to manage its operations, similar to any standalone company. This operational scope includes entering into contracts, owning assets, and borrowing money.

The subsidiary has the autonomy to conduct business transactions, manage its finances, and pursue objectives that align with the strategic goals of the parent company. This autonomy allows subsidiaries to adapt to market changes, innovate, and respond to customer needs with the agility of a smaller enterprise, while still leveraging the resources and stability of the larger corporate structure.

Strategic Role and Alignment

Subsidiaries often serve specific strategic purposes for the parent company, such as entering new markets, diversifying company interests across different industries, or managing parts of the business that require specialised knowledge or operations.

By operating through subsidiaries, a parent company can spread its risk across different entities and ensure that financial or operational challenges within one subsidiary do not directly impact the broader organisation.

Legal and Financial Distinction

Legally, subsidiaries are separate entities from their parent companies. This separation is crucial for liability purposes, as it typically insulates the parent company from legal challenges or debts incurred by the subsidiary.

Financially, while a subsidiary manages its own budget, investments, and revenue generation, its financial performance directly contributes to the parent company’s overall financial health. The parent company may also provide financial support to its subsidiaries in the form of capital injections or guarantees for loans.

Governance and Control

While subsidiaries operate independently, their strategic direction and major decisions are often influenced or directly controlled by the parent company. This control is usually exercised through the parent company’s ownership of the subsidiary’s voting stock, allowing it to appoint board members and influence or dictate major business decisions.

Despite this control, subsidiaries often retain a level of operational autonomy, enabling them to understand their specific market conditions effectively.

 

Subsidiary Company Advantages

Tax Advantages

Setting up subsidiary companies in various locations allows a parent company to benefit from more favourable tax laws and structures that might exist outside the parent company’s home country. This arrangement can lead to significant tax savings, including the ability to consolidate profits and losses across the group to minimise the overall tax burden.

Asset Protection

By operating through subsidiary companies, a parent company can shield itself from legal liabilities. Since subsidiary companies are distinct legal entities, financial troubles, lawsuits, or losses they incur typically do not impact the parent company directly, thus offering a layer of protection against risks.

Operational Efficiency

Subsidiary companies situated in local markets can operate more effectively by tailoring their operations and strategies to the specific needs and conditions of those markets. This localised focus enhances responsiveness and competitiveness, which might be cumbersome for a parent company managing from afar.

Subsidiary companies serve as a strategic vehicle for parent companies looking to enter new geographical regions. This approach allows for market expansion with reduced risk and capital investment compared to starting from scratch or acquiring existing businesses.

Strategic Flexibility

Subsidiary companies offer a flexible framework for experimenting with new products, business models, or market strategies without exposing the entire parent company to potential failures or risks. This flexibility enables the parent company to adjust its strategy by scaling, divesting, or closing subsidiaries based on performance and strategic fit.